A Look Ahead
Looking back a year, we had all hoped that by now COVID would not be impacting our lives still. However, as we are all aware, COVID continues to influence what we do, how we do it, and where we go. Modern medicine has certainly allowed our economy and lives to reopen and move closer to a “normal” life with widespread vaccinations and newly developed antiviral drugs, but new variants continue to limit a complete return to pre- COVID life. Many people are tired of it and are ready to move on, but we are reminded daily that we cannot control everything around us. We will likely need to learn to live with this virus for some time in the future.
As we head into 2022, the headlines may focus on the negative impact of COVID, but the U.S. economy continues an upward growth trajectory. Consumers remain confident, jobs are plentiful, and strong housing and equity markets have increased household net worth. The focus has been on the wealthy benefiting the greatest from the equity market, which may be true, but anyone invested in a retirement plan also benefited from the rising equity tide. When all is tallied, 2021 will be the fastest-growing economic year since the mid-1980s and will have the highest annual inflation rate as measured by the Consumer Price Index (CPI) in 40 years. Supply chain issues, labor shortages, and strong demand have led to higher prices across the board. As we discussed last quarter, some inflationary pressures will subside in 2022, but a higher inflationary environment than we have experienced in several years will remain.
With the higher inflationary environment, the Federal Reserve (Fed) has begun to taper bond purchases and anticipates March as an end date. Once tapering is completed, it opens the door for the Fed to begin gradually increasing the overnight rate. Since March 2020, the Fed has been accommodative and provided substantial liquidity to the market. In addition, fiscal stimulus from mid-2020 to earlier this year added liquidity to the market. At the time these programs were first implemented, it was a strong and bold response to provide support to the economy to avoid a long-term downturn. The reopening of the U.S. economy, which began in late 2020, along with the high levels of accommodation and stimulus, have resulted in strong demand, strong markets, and inflation. As we enter 2022, fiscal stimulus will be far less with no imminent bills being passed. Liquidity will be substantially less than experienced in the last 21 months and should result in slower economic growth, less speculation in the market, and with slower growth, potentially lower inflation.
While we anticipate GDP growth in the 3% to 4% range, there are risks to our outlook. One risk is whether the Fed moves more aggressively raising rates than the market anticipates. We do not believe the Fed will do this but need to be cognizant of the risk. Chairman Powell stated that the rate moves are data-dependent and specifically mentioned the supply chain issue, inflation, and tight labor market. Its mandate is full employment and a 2% inflation level. Currently, we believe that we are at or near full employment, but the inflation rate is higher than the Fed is comfortable with. We are anticipating it will lessen as the supply chain issues are worked out over the next 12 months. If the Fed raises rates too aggressively, the tighter monetary policy could lead to a dramatic slowdown and a potential recession in 2023. We believe the probability of this happening is extremely low at this time.
The second risk to our outlook is that the Omicron variant, or any other COVID variant, leads to shutdowns during 2022. Europe is currently limiting many activities due to the spread of Omicron. However, in the United States, only sporting events, theater shows, and other events have been canceled because of illness among performers and athletes. The economic ramifications from the 2020 shutdown are still lingering, and the long-term impact is yet to be determined. While the odds of another shutdown are minimal, we do not want to ignore the potential risk.
Since March 2020, there has been minimal volatility in the markets with a fairly straight upward trajectory. We believe the equity market will provide more opportunity for investors in 2022 than the fixed income market. We are anticipating greater volatility as the market digests the Fed actions, inflation, and company earnings. Fixed income investors will see minimal positive returns and potentially even negative returns if interest rates increase during the year. Our outlook for the markets leads us to remain overweight equities in our portfolios and underweight fixed income. Within the equity holdings, we believe that the developed international market will see a reopening trade, and we favor it slightly over domestic equities. High-quality companies with stable earnings growth will be preferred both domestically and internationally. Within the fixed income portfolio, we favor average maturity shorter than the targeted benchmark.
As always, we appreciate your trust in us and wish each of you a happy, healthy, and prosperous new year.